A 58-year-old former corrections officer retires with a state pension and buys 100 goats. He builds portable electric fencing and rents the herd to clear overgrown fields, vacant lots and utility rights-of-way. The goats eat nearly anything. The business consumes nearly everything else. Hay, veterinary care, worming medicine, fuel, fencing and trailer repairs exceed what customers pay. After expenses, the operation shows a loss.
That creates a problem he did not expect. His corrections job belonged to a public pension system that did not participate in Social Security. Earlier private-sector jobs earned him 36 Social Security credits, four short of the 40 generally required for retirement benefits. The goat business lost money. Under an obscure tax election, it may still be able to buy him the final four.
How a Loss Can Produce Social Security Credits
Self-employed workers ordinarily pay Social Security and Medicare taxes on net earnings. If business expenses wipe out the profit, there are generally no net earnings, no self-employment tax and no Social Security credits. The optional methods on Schedule SE can change that result.
Depending on how the goat operation is classified and whether he meets the requirements, he may be allowed to report a limited amount of deemed net earnings based partly on gross income. He voluntarily pays self-employment tax on that amount, and Social Security uses those reported earnings to award credits. The IRS expressly says the optional methods can provide Social Security coverage when a self-employed person has a loss or only a small profit. This is not a deduction or a refund strategy. He is choosing to pay tax he otherwise might not owe because the coverage is worth more to him than the tax.
The Goats Create a Classification Question
The tax treatment depends on what business he is actually operating. If he is raising livestock as part of a farming operation, the farm optional method may apply. That method has its own income limits and can be used even when the farm reports a loss. Unlike the nonfarm version, it does not carry a five-year lifetime limit.
If he is primarily selling brush-clearing services and reports the activity as a nonfarm business, the nonfarm optional method follows different rules. He generally must have had at least $400 in actual net self-employment earnings during two of the previous three years, and he can use that method for only five years over his lifetime.
Owning goats does not settle the classification. Neither does describing himself as a farmer. What he sells, how he operates and where the income belongs on the return determine which optional method is available. That is why the decision belongs with a tax professional who understands both farming and self-employment reporting.
Four Credits Can Be Worth More Than a Larger Check
Social Security awards up to four credits per year based on covered earnings. Credits determine whether someone is insured for retirement, disability and survivor benefits. They do not directly determine the size of the monthly retirement check. His benefit amount will still be calculated from his lifetime covered earnings. The deemed earnings reported under an optional method enter that record and could raise the eventual benefit slightly, especially if they replace a zero among his highest 35 years. But the increase is likely to be modest because the optional amount is capped.
The larger prize is eligibility itself. Thirty-six credits do not produce a reduced retirement benefit. If 40 are required in his case, he either reaches the insured-status line or he does not. His state pension does not supply the missing credits. The repeal of the Windfall Elimination Provision stopped Social Security from shrinking benefits because of a pension from noncovered work, but it did not erase the requirement to earn enough Social Security credits in the first place.
Check the Record Before Paying the Tax
Before making the election, our goatherd should pull his Social Security earnings record and verify the exact number of credits already earned. Old private-sector wages may be missing, and correcting the record could be cheaper than voluntarily creating deemed self-employment income.
He should then ask a qualified preparer four questions:
- Is the goat operation properly classified as farm or nonfarm activity?
- Does it meet the current income limits for the applicable optional method?
- If it is nonfarm, does his recent self-employment history satisfy the two-out-of-three-year test?
- Will the deemed earnings produce all four credits, fewer than four or none?
If he already has 40 credits, paying additional self-employment tax solely for insured status makes little sense. If he has 36, the calculation changes sharply. The goats cleared the land but not the profit line. The optional method lets him decide whether a losing business should also clear the final hurdle between a pension and Social Security eligibility.
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